Q. What is the difference between a stock option plan and stock purchase plan?

A. A stock option gives an employee the right to purchase stock at a predetermined price, regardless of the fair market value of the stock. A stock purchase option, available through an Employee Stock Purchase Plan, gives an employee the right to purchase company stock, sometimes at a predetermined discount from the fair market price. Although the plans are similar, they are not the same.

Both kinds of plans can be either qualified for special tax treatment or unqualified. Both can be of great benefit to employees. Both can be offered to an exclusive group of participants as in the case of non-qualified Employee Stock Purchase Plans, or to all full-time employees under qualified plans.

A. Stock options do expire. The expiration period varies from plan to plan. Track your options’ exercise periods and expiration dates very closely because once your options expire, they are worthless. There are often special rules for terminated and retired employees, and employees who have died. These life events may accelerate the expiration. Check your plan rules for details about expiration dates.

A. Your plan may have a vesting period that affects the time you have to exercise your options. A vesting period is time during the term of the option grant that you have to wait until you are allowed to exercise your options.

Here’s an example: If the term of your option grant is 10 years, and your vesting period is two years, you may begin exercising your vested options as of the second anniversary date of the option grant. This essentially means you have an eight-year time frame during which you can exercise your options. This is called the exercise period.

Generally, during the exercise period, you can decide how many options to exercise at a time and when to exercise them.

A. Think of your Fidelity Account as an all in one brokerage account offering cash management services, planning and guidance tools, online trading, and a wide range of investments like stock, bonds and mutual funds. Use your Fidelity Account as a gateway to investment products and services that can help meet your needs. Learn more.

Frequently Asked Questions About Taxes

Q. Are there tax implications when stock options are exercised?

A. Yes, there are tax implications – and they can be significant. Exercising stock options is a sophisticated and sometimes complicated transaction. Before you consider exercising your stock options, be sure to consult a tax advisor.

Q. Last year, I exercised some non-qualified employee stock options in an exercise-and-sell transaction (a “cashless exercise”). Why are the results of this transaction reflected both on my W-2 and on a Form 1099-B?

A. Fidelity works to make your exercise-and-sell transaction simple and seamless for you, so it appears to you to be a single transaction. For federal income tax purposes however, an exercise-and-sell transaction (cashless exercise) of non-qualified employee stock options is treated as two separate transactions: an exercise and a sale.

The first transaction is the exercise of your employee stock options, in which the spread (the difference between your grant price and the fair market value of the shares at the time of exercise) is treated as ordinary compensation income. It is included on your Form W-2 you receive from your employer. The fair market value of the shares acquired is determined under your plan rules. It is usually the price of the stock at the prior day’s market close.

The second transaction – the sale of the shares just acquired – is treated as a separate transaction. This sale transaction must be reported by your broker on Form 1099-B, and is reported on Schedule D of your federal income tax return.

The Form 1099-B reports the gross sales proceeds, not an amount of net income; you will not be required to pay tax twice on this amount. Your tax basis of the shares acquired in the exercise is equal to the fair market value of the shares minus the amount you paid for the shares (the grant price) plus the amount treated as ordinary income (the spread). In an exercise-and-sell transaction therefore, your tax basis will ordinarily be equal to, or close to, the sale price in the sale transaction.

As a result, you would not ordinarily report only minimal gain or loss, if any, on the sales step in this transaction (although commissions paid on the sale would reduce the sales proceeds reported on Schedule D, which would by itself result in a short-term capital loss equal to the commission paid).

An exercise-and-hold transaction of non-qualified employee stock options includes only the exercise part of those two transactions, and does not involve a Form 1099-B.

You should note that state and local tax treatment of these transactions may vary, and that the tax treatment of incentive stock options ("ISOs") follows different rules. You are urged to consult your own tax advisor regarding the tax consequences of your stock option exercises.

A. The Alternative Minimum Tax (AMT) is a tax system which complements the federal income tax system. The goal of the AMT is to ensure that anyone who benefits from certain tax advantages will pay at least a minimum amount of tax. For more information about how the AMT may affect your situation, contact your tax advisor.

Q. How do I pay the taxes when I initiate an exercise-and-sell transaction?

A. The taxes owed on the gain (fair market value at the time you sell, less the grant price), minus brokerage commissions and applicable fees from an exercise-and-sell transaction are deducted from the proceeds of the stock sale. Your employer provides tax-withholding rates. See Exercising Stock Options for more information. You may want to contact your tax advisor for information specific to situation.

Q. How can I determine what the tax implication may be if I sold my shares?

A. Under Select Action - positions/cost basis, Fidelity displays in blue the gain/loss for the specific lot. After clicking on the lot, the following message may appear:

Your reported sales transactions include one or more sales of shares you acquired through an equity compensation plan that are disqualified dispositions for tax purposes, gain from which may be treated as ordinary income rather than capital gain.